Paying people effectively has always been a tricky subject. There are some people who claim they are being underpaid. And then there are some who you think are being paid more than the value they bring. So how do you strike a balance that makes people feel fairly paid and valued while accommodating your business goals? One of the main debates is whether you should compensate based on the cost of living or the cost of labor. This question is more than theoretical—it directly impacts employee satisfaction, cost management, and market competitiveness.

Why is There a Debate on Cost of Living vs. Cost of Labor?

This debate has become increasingly relevant for several reasons:

Changing Demographics: Remote work allows employees to live far from the traditional corporate hubs, which means they might reside in smaller towns while working for a company based in a major city.
Inflationary Concerns: Post-Covid, food inflation has risen in most parts of the world, and other costs have spiraled too. Because of high inflation, people feel they are left with less money than in earlier times and they expect employers to address the gap.
Heightened Competition: Companies competing for top talent must navigate how pay structures impact their attractiveness as employers.

The core question arises: should salaries reflect the cost of living in an employee’s location or the cost of labor associated with their skills? This is not an easy call, but making the wrong decision can lead to higher operational costs or perceived pay inequities.

Defining Cost of Living and Cost of Labor

To make an informed decision, it is essential to understand the difference between the two:

Cost of Living: It refers to the expenses required to maintain a specific standard of living in a given area. Larger cities like San Francisco or Mumbai have higher living costs than smaller towns, influencing employees’ salary expectations to cover housing, transportation, taxes, and other necessities.
Cost of Labor: It is determined by the demand and supply of labor for specific skills in the market. It reflects the economic value of a role and the competition for talent, regardless of where the employee resides.

Why It Matters

Balancing the cost of living and cost of labor considerations is vital to ensuring that companies remain attractive to talent while maintaining fair and competitive compensation practices.

How Companies Are Handling the Debate

Companies navigate the complexities around the topic by primarily focusing on the cost of labor to determine their compensation strategies.

Base pay is typically benchmarked with the cost of labor to stay competitive in attracting and retaining talent. This approach ensures that pay rates align with the prevailing market conditions for specific roles and skills. For instance, a senior accountant in Chicago might command a higher salary than one in El Paso due to the higher cost of labor in Chicago.
Cost of living is usually not the primary determinant for setting base pay but it can become relevant in specific situations such as employee mobility. In such cases, companies may offer temporary allowances or adjustments to help employees transition to areas with higher living costs. These adjustments are often phased out over time as employees acclimatize to the new environment.
In periods of high inflation, companies face pressure to adjust compensation to help employees cope with rising living expenses. However, adjusting pay to counter cost of living increases can lead to unsustainable wage inflation.

Instead of permanent pay increases, you should consider one-time grants or stipends to address the short-term economic challenges without committing to long-term salary hikes.

However, an important consideration to remember is that over a period of time, the cost of living gets built into the cost of labor. For example, apartment rents in California are likely to be nearly twice as high as those in Alabama. As a result, companies hiring in California are likely to accommodate that difference in their pay ranges.

Conclusion

Cost of living vs. cost of labor may seem to be a binary choice. But by focusing on the cost of labor, you can usually address concerns pertaining to cost of living as well and ensure your people are fairly paid and feel valued.

How can CompTeam help?

Navigating compensation isn’t always easy, especially with all these moving parts. That’s where CompTeam comes in. We help you create compensation strategies that balance the cost of living, the cost of labor, and everything in between.

Here’s how we can support you:

Tailored compensation models: We help you build a strategy that reflects your company’s goals and ensures you stay competitive.
Market analysis: We can conduct thorough research to help you understand how much you should be paying based on skills, geography, and industry trends.
Building pay structures: Whether it is the cost of living, cost of labor, or a hybrid approach, we will design pay structures that keep your employees happy and motivated.
Ongoing support: Compensation is a long game. We’re here to help you adjust and adapt your strategy as your company and workforce evolve.

At the end of the day, you want to pay people fairly and keep your company competitive. With our expertise, we’ll make sure you strike the right balance. For a detailed conversation on this, reach out to us at [email protected].